6/10/2002 @ 12:00AM

Economy And Empire

All great empires come to a point of accelerating inflation, rising interest rates and a sharp depreciation of their currency. The U.S. empire may be facing this now.

According to several articles that have appeared in the international press, some notable U.S. commentators and scholars believe that America is no mere superpower but a full-blown empire in the Roman and British sense. Great news if you consider the alternatives, such as a Chinese or Russian empire, no longer communist but still totalitarian in nature.

The bad news, however, is economic. All great empires come to a point of accelerating inflation, rising interest rates and a sharp depreciation of their currency. The U.S. empire may be facing this now.

In the History of Interest Rates, Sydney Homer notes that interest rates have moved in “repetitious patterns” over the centuries and that there was “a progressive decline in interest rates as the nations or cultures developed and throve, and then a sharp rise in rates as each declined and fell.’”

U.S. interest rates were in a long-term declining trend between 1800 and the 1940s, when U.S. long-term government bond yields bottomed out below 2%. They have since risen irregularly.

Consider the Roman Empire. Until the rule of Nero, the Romans used only pure gold and silver coins. But, having run out of money, Nero proclaimed in A.D. 64 that henceforth the aureus would be 10% lighter in weight. He also minted a new silver coin, which was not only lighter in weight but also contained about 10% copper, which made it worth about 25% less than the old one.

Nero set an important precedent: From the time he was deposed until the sacking of Rome by the Goths and Vandals in the second half of the fifth century, a succession of emperors continued the practice of increasing the supply of money in the empire by debasing the currency, which in the end had only a 0.02% silver content!

Roman demand for money was insatiable because it was plagued by endless problems, including border wars, slave rebellions, peasant uprisings, provincial struggles and a heavy dependence on imported goods. Each time a new problem cropped up, more coins were minted, leading to further debasement of the currency and higher inflation–two factors whose importance in the fall of Rome cannot be overlooked.

It’s no coincidence that Nero’s currency devaluation occurred as the empire began to weaken, which I suppose is analogous to President Nixon’s closing of the gold window in August 1971 after the U.S. had reached its peak in terms of economic hegemony, which I place in the 1950s or 1960s. Under the Emperor Trajan (A.D. 98-116), the economy on the Italian peninsula had experienced a terrific slump because its wines were no longer competitive with wines coming from the western provinces. Similarly, manufacturing in the U.S. has gradually been undermined by new centers of production south of the border and in Asia, especially now in China.

The 16th-century Spanish Empire under Philip II is another apposite case study. After Spain’s unification with Portugal in 1580, it was by far the largest territory a sovereign state ever ruled. But prosperity was short lived, because the gold and silver, which flowed in the 16th century to Spain from its mines in Mexico and elsewhere, was again spent on a series of costly wars, inevitably leading to rapid price increases. The Spanish Crown defaulted on its loans in 1557, 1575, 1596, 1607, 1627 and 1647, which led to serious crises in Antwerp, Genoa and Lyon, since they were the prime financiers of the Spanish loans.

What about Britain? Unlike Rome and Spain, Great Britain did not depend on its colonies for its wealth. Its manufacturing sector was well ahead of other nations. In 1830 Lancashire had more machines installed than the rest of the world combined. But over time the British Empire also proved to be extremely costly to maintain, and in the 20th century Great Britain had to successively give up its overseas possessions, while its domestic industries lost their competitiveness, reflected in the pound sterling’s gradual depreciation against strong currencies.

In 1915, a pound bought 25 Swiss francs; today it buys only about 2.5. Moreover, though U.S. interest rates bottomed out in the 1940s, British interest rates had already reached their all-time low near the empire’s zenith in 1896, when yields on Consols (a type of bond) fell to 2.2%. Thereafter, Consol yields never again reached these low levels–not even during the Great Depression.

In the long run, empire maintenance proves to be far too costly and inevitably leads to inflation, rising interest rates and a depreciating currency. This is not to say that there are no good investment opportunities in empires, but better opportunities arise elsewhere.

If I am right in assuming that the U.S. empire is already past its peak, then we will have to get used to higher inflation and interest rates and a weakening dollar. My advice is to avoid U.S. financial assets and invest in Asian stocks and also in such commodities as gold and grains.